Earnings Call: Q1 2018

Apr 20, 2018

Good morning. My name is Crystal, and I will be your conference operator today. Thank you for joining us for this conference call for OFG Bancorp. Our speakers are Jose Rafael Fernandez, President, Chief Executive Officer and Vice Chairman Ganesh Kumar, Senior Executive Vice President and Chief Operating Officer and Maritza Aurizmendi, Executive Vice President and Chief Financial Officer. A presentation accompanies today's remarks. It can be found on the Investor Relations website on the homepage in the What's New box or on the Webcast Presentations and Other Files page. This call may feature certain forward looking statements about management's goals, plans and expectations. These statements are subject to various risks and uncertainties outlined in the Risk Factors section of OFG's Securities and Exchange Commission filings. Actual results may differ materially from those currently anticipated. We disclaim any obligation to update information disclosed in this call as a result of developments which may occur afterwards. All lines have been placed on mute to prevent any background noise. And after the speakers' remarks, there will be a question and answer session. I would now like to turn the call over to Mr. Fernandez. Good morning. Thank you for joining us today. I will review the quarter's results. Ganesh and Maritza will join us for the Q and A. As we've done in recent calls, we'll focus our prepared remarks on key highlights and then we'll open the call for questions. Please turn to Slide 3. This morning we reported strong first quarter results. Earnings were $0.29 per share that is similar to 4th quarter and 12% higher than a year ago. We experienced strong performance across the board. Net loans grew 8% on an annualized basis from the last quarter. New loan generation was more than $300,000,000 in the quarter. Customer deposits increased 2% from December 31 and net interest margin expanded 14 basis points. Credit also performed well. Nearly all of our loan moratoriums expired during the quarter. Most of our credit metrics were better than or returned to pre hurricane levels. Our strong capital position continued to build. Tangible book value per common share increased 2.5% year over year to $15.71 Total risk based capital ratio continued to exceed 20%. Please turn to Slide 4. Our first quarter results reflected both the success of our strategies and Puerto Rico's emerging recovery. Today marks 7 months since Maria hit the island. Puerto Rico is now benefiting from a wide variety of factors, Loan payment moratoriums by Oriental and other banks, increased availability of electric power, improvement in communications, all of which has led to return of day to day stability. In addition, the island is benefiting from rebuild spending by FEMA, the start of payments of insurance claims and the prospect of a growing amount of federal funds. This has enabled OFG to return to our performance prior to the hurricanes and is setting the stage for potential future growth. Please turn to Slide 5. Nearly every metric in the Q1 confirmed our progress. For the Q2 in a row, our originated loan growth outpaced the pay down of acquired loans. Auto, consumer and mortgage loan production at $192,000,000 increased 52% from the 4th quarter and more than 11% from the year ago quarter. At a record $128,000,000 auto reflected consumers' need to replace damaged vehicles, pent up demand and the market's effort to adjust to 1 less auto lending competitor. Consumer loan production rebounded more than 60%, exceeding pre hurricane levels as retail customers began to replace needed items and repair homes. Mortgage loan production also rebounded more than 60% as it became easier to sell and buy homes again. Commercial loan production in Puerto Rico was lower than the 4th quarter, but up more than 13% year over year. Our bankers are continuing to build relationships with businesses participating or positioning themselves to participate in Puerto Rico's recovery. And our recently established OFG USA program added $74,000,000 in commercial and industrial related loans. These consisted of participations across a broad array of industries and geographies on the mainland. While pricing on originated loans declined 6 basis points, net interest margin got a boost from higher yield in investment portfolio and from cash balances. Please turn to Slide 6. Other business trends were positive or heading into the right direction. Fee revenue came back with a 24% sequential increase in banking services and a 43% increase in mortgage banking. Core Wealth Management held steady at pre hurricane levels. Customer deposits increased $78,000,000 while the cost of deposits continued to decline. We are pleased to note that we benefited also from non interest bearing accounts totaling more than $1,000,000,000 for the first time. The efficiency ratio returned to pre hurricane levels, but there were some seasonally higher expenses there. Please turn to slide 7. Credit quality remains stable. The net charge off rate remained level with the 4th quarter. Within the mix, the rate for consumer lending increased, returning to pre hurricane levels, while the rate for other categories remained flat or declined. Non performing loan rate increased 51 basis points due to 1 commercial loan and auto loans coming off moratoriums. The commercial loan is for $10,500,000 It is current in its monthly payments, but we placed it in non accrual due to credit deterioration post Maria. Total delinquencies returned to pre hurricane levels as most of the moratoriums expired. You might recall delinquencies fell during the Q4 due to lower inflows reflecting the automatic moratoriums we offered and to a lesser degree payments received on moratorium loans. Please turn to Slide 8. If you recall, the 3rd and 4th quarters included incremental provisions to increase the allowance for hurricane related impacts on loans. In the Q1, total provision fell more than $9,000,000 from the 4th quarter to $15,500,000 Even with that decline, 1st quarter provision included $8,600,000 to replenish the allowance for retail loan charge offs related to the hurricane. 1st quarter provision also included an increase in allowance related to auto loan portfolio growth and for that one commercial loan placed in non accrual that I mentioned earlier. As a result, we continue to increase our allowance both in dollars and in percentage of loans held for investments. Please turn to Slide 9. Another factor in our success has been our ongoing efforts to differentiate Oriental through superior service and digital banking technology, what we call our VIVE La Differentia strategy. This quarter, we introduced MyPayments, Miss Pago's, enabling our loan only customers to pay online instead of standing in line at a branch. As a result of efforts like this, we're proud to report net new customer accounts grew at an annualized rate of 8% in the Q1. This significantly exceeds our 2% increase for the full year 2017, which was affected by the hurricanes and it also exceeds our 5% rate in 2016. Please turn to Slide 10 for our capital ratios. We'd like to point out that our capital metrics have continued at the high levels we saw in 2017, which were significantly higher than 5 years ago. And please turn to Slide 11 for our outlook. With power and telecom getting close to complete, although not reliable, restoration to day to day life has begun stabilizing for businesses and consumers. We're also starting to benefit from insurance money and federal spending trickling down through the economy. On a more personal level, we're beginning to see some optimism building on Puerto Rico's business leaders and entrepreneurs. But I'm going to have to repeat some of what I said on the last call. Puerto Rico is far from being out of the woods. Short term, we're still waiting for insurance and federal money to really start flowing. Long term, we must develop a lasting solution to PREPA. Lower cost, reliable, resilient, independently regulated electric power is the single most important thing Puerto Rico needs today. We also must permanently resolve the island's fiscal problems. The fiscal plan approved yesterday by the fiscal board provides that opportunity. It is time for the government to execute that plan without delays. As we've seen from this quarter results, OFG and Oriental are continuing to play a major role leading the way for consumers and businesses. While we remain cautious in the short term due to the uncertain economic environment on the island, we are confident positive momentum will prevail in the long term for OFG, Oriental and Puerto Rico. Our goal is to continue to sharpen our focus on our retail and commercial clients, improve our service levels, expand our business and build capital. With this, we end our formal presentation. Operator, please open the call for questions. And our first question comes from the line of Brett Rabatin with Piper Jaffray. Hi, good morning everyone. Good morning. Good morning, Brett. I wanted to I have quite a few questions, but wanted to just, I guess first start macro and this is probably the most optimistic. I've probably heard you guys in a while and probably more so than when I was on the island during the quarter. Assuming that the insurance monies do start to flow more, We had $7,000,000,000 more from HUD, the plan fiscal plan announced or I guess certified yesterday, the governor is not on board. But assuming monies flow heavier to the island in the next quarter or 2, I mean, can this actually help the economy grow in the near term? Brett, I think it's a little too early to tell. There are too many uncertainties still out there. So given our Q1 results, we're certainly cautiously optimistic. We had a very good quarter. We have terrific results and we can't hide that reality. But we also can hide the fact that there are still too many uncertainties in Puerto Rico. And particularly yesterday, the fiscal plan that was approved, there is a clash between the government and the fiscal board in the implementation on how to implement some of those difficult measures. So, it's going to end up in a protracted it seems to me that it's going to end up in a protracted legal bankruptcy process. And that process is going to be in the hands of a federal judge and she needs to kind of put the ring around the collar, so to speak so that we can in reality do the right thing from a fiscal perspective. So I say this simply because from our business perspective, it's a little too early for us to say the economy is going to grow and we have here great backwind coming in with federal funds because it seems to me that if the governor and the government of Puerto Rico fights the fiscal plan, the treasury of the United States will also have a little bit of leverage with federal funds and we're a little bit uncertain on how those funds are to flow if there is a protracted fight among the 2 main players in the island, the government and the fiscal board. Okay. And then wanted to maybe get a little thought process on just one, I know the press release said that the $74,000,000 in the U. S. Was varied and across different industries, but was hoping to get maybe a little more color on that piece of the production, just granularity there. And then if we're thinking about 2018 and that continuing to bolster your portfolio, can we now assume that you guys might have loan growth in the 8% to 10% range this year? Or can you give us maybe a little more color on your outlook for production on loans and then how you see the U. S. Strategy aiding that? So again, I'm going to let Ganesh give you the details, but from a big picture, the way we got this going is primarily to diversify geographically and that remains the main objective here. And we had certainly a good quarter on that area. So I'll let Ganesh give you some of the details. Good morning, Brett. So as I pointed out, the primary objective is prudently build a portfolio that's diversified not only in geography, but also industries as well. So the production is primarily is made up of different credits in form of participations at this point in time. And though we plan to add whole loan purchases to the program during the course of the year, And we are still working on possibilities. So at this point in time, those participations came, the ticket item, ticket size is anywhere between $4,000,000 to $10,000,000 well diversified across manufacturing, transportation and all those basic industries we understand over here without any exposure to any esoteric businesses. And the credit quality, we are being very cautious as well in terms of the leverage and credit ratios. And we are trying to pick those companies, especially that have proven track record and have a hold on their respective markets so that we can feel comfortable about their future performance as well. So having said that, we were we are happy in terms of what the team has been able to do this quarter. But at the same time, as I said last quarter, we do not have a number specific target in play in our minds. We are going to be opportunistic to continue either continue at the same level or if we don't, we would probably prioritize the credit aspect of it first before running before going after any number. Okay. Fair enough. And maybe just one last one. Your delinquency trends are still basically below pre hurricane levels. What would you expect from your various portfolios as we go forward kind of given the insurance money showing up? Should delinquencies in your view top out here or should are you thinking they'll go higher? So Brett, what I would say is we're certainly encouraged with the delinquency trends. There are some areas that we need to keep an eye on them. And our servicing teams are focused on making sure that proactively they identify those areas and work with the consumers to help them out. And again, given the uncertainties, we want to make sure that we give ourselves 1 more quarter to make sure that we feel the trends are moving in the right direction. But we're certainly encouraged with the trends post Maria and post moratorium. Okay, great. Appreciate all the color. Yes, you're welcome. Our next question comes from the line of Alex Twerdahl with Sandler O'Neill. Hey, good morning. Good morning, Alex. Just first off wanted to ask for a little more color on the provision, the $8,600,000 that was used to replenish the allowance for retail loans charged off related to the hurricanes. What were there specific characteristics that made these charge offs hurricane related versus the other charge offs during the quarter? [SPEAKER JOSE RAFAEL FERNANDEZ:] So again, I'm going to give you a little bit big picture and I'll let Maritz answer that. But we look at our provisioning based on our methodology and we remain as we've been in the past consistent with that methodology. So I'll let Maritza give you some details. Yes. Generally speaking, this quarter, we most of our moratorium expires and discharge was delayed to clients that were participating under that moratorium and were related to the hurricane. Okay. So there were charge offs of loans that were specifically on moratorium came off and then they were charged off for whatever reason. So if I how should we think about the reserve methodology? And I know you kind of touched on it there for a second, but over the next couple of quarters, I mean, in the 3rd Q4 of last year, you put up, I think, something like $30 plus 1,000,000 of reserves that you specifically of replenishment? Or at what point do you think that $30,000,000 whatever you put aside for the hurricanes actually will start to come down? As Jose was mentioning before, we will consistently assess the adequacy of the allowance for loan losses each quarter, assessing the risk associated to the loan portfolio, including the risk from the hurricanes. So we will need to see how each portfolio behaves and we will assess that as time goes by. Okay. And then Jose, I appreciate some of the comments you had about the macro outlook for the island and obviously still a lot of uncertainty out there following the hurricane, following the fiscal plan. But you did put up a pretty nice quarter for loan originations. You've had some nice deposit flows. Do you think that this is kind of a blip following the hurricane? Or do you think that some of these levels that we're seeing here kind of more representative of a new normal and that the pipelines are still pretty strong and we could see some of these type of origination paces and deposit growth paces continue at least for the next couple of quarters? So the way we think about this is we had a very good quarter and it's going to be very hard to replicate this stupendous quarter on an ongoing basis given the uncertainties that we operate in. If we wouldn't have the uncertainties, we would address the results or conclude that the results are 100% due to it's are hard are hard to ignore. So we are happy about our results, but we are cautiously optimistic. And what I would point out to all of you is that let's see how the Q2 goes. And once we have a call after the 2nd quarter results, we could be more specific on how we see the rest of the year. But there's still too many uncertainties out there, Alex. Okay. Thank you very much for taking my questions. You're welcome. Your next question comes from the line of Joe Gladue with Marion Capital Group. Good morning. Good morning, Joe. Good morning. I guess I first wanted to touch base a little bit on the loan production and I guess I'll look ask about the commercial side first. You noted that there was a decline from Q4 but increase from Q1. But I guess I'm looking for a little color on your feeling about the commercial side given I might have expected some increase just from people businesses recovering from the hurricane and looking to rebuild. On the other hand, I know a number of businesses closed following the hurricanes and that would suggest declines. I guess I'm just wondering if you can help us out where you guys think that those, I guess, countervailing pressures fall out? Yes. So I think two things come to my mind. One is we have a pretty good pipeline going forward, but we also have to admit that the competition is pretty fierce. And when we look at pricing and how aggressive some of these pricings are going in on the commercial side, we need to be cognizant of that too in an economy that it's still even though showing signs of recovery given the what we have spoken earlier in the call, it's still a very competitive market, particularly on the commercial middle market, what we call middle market, which is our sweet spot, dollars 1,000,000 to $10,000,000 type of loans. So that's why I think you're going to see a more steady performance from the commercial business here in Puerto Rico or for Oriental. I think what you're going to see this quarter's numbers is probably on the lower end of our range to probably be a little bit better in the next quarter, but I wouldn't go further than that. Okay. All right. And I guess the next question, you touched on it a little bit there, but the loan pricing and again noting that the average yield on non acquired loans was down from Q4 to Q1. Just wondering how much of that is competitive pricing on the island? How much of that is related to the U. S. Portfolio and where do you see that going? It has to do a lot with the mix. So when we have a larger component of auto and consumer, it helps us out. But when also you have a more participation there on the commercial side, the Puerto Rico and the U. S, then it pushes down the average yield on the production. So that's what's moving it. But in general, remember we had a pretty good auto loan quarter in terms of production, but we also added some additional commercial loans in Puerto Rico and the U. S. And that has a little bit of a pressure on the yield on that production. Okay. And I guess I'll just ask, I imagine there's a lot of deposit inflows on the island given the disaster funds and insurance funds. I just ask you to touch on the competitive environment in terms of deposit pricing. I would say it's competitive and we're starting to see some players becoming a little bit more aggressive on CD pricing and that's kind of where we're seeing it right now. We're also seeing a little bit of a on the deposit side, there's a little bit of a volatility given the insurance companies depositing funds with the banks in the island. So that money is going to come in and out as they start paying the claims. But in general, when we look at our bank, our retail side of the deposit client is doing very well. We're growing good clients as we talked about in our prepared remarks. We're adding net new customers at a yearly clip of 8%. That is tremendous. And I think that's a good boost for the deposit side of it. On the commercial side, we're very encouraged with our non interest bearing deposits breaking the $1,000,000,000 and that's very encouraging for the relationships we have built so many years on the commercial side, on the small business and the middle and larger commercial relationships that we have. And so the trends for 3 quarters in a row have shown very positive trends on the deposit side. So we're very happy with that. So far, we're not seeing the level of, let's say, pressure on increasing the cost of funds as you guys are seeing in some of the banks in the States. All right. Thank you. Thank you, Joe. And our next question comes from the line of Glenn Manna with KeyBanc and Woods. Hi, good morning. Good morning, Glenn. I just wanted to ask you a question on the credit side because I think especially when you look at early stage delinquencies, they compare so favorably with Q1 2017, especially after the hurricane. Investors have questioned what would happen after your customers came off the moratorium. Would you say that significantly most of your customers that took advantage of a moratorium had they not been paying would have showed up in your early stage delinquencies this quarter? Or is there still a portion that could kind of migrate in, in the Q2? Yes. We're still waiting and see. We're very encouraged with the numbers for this quarter. Remember, most of the moratorium just I would say almost all the moratoriums are done. Maybe we have a trickle of some moratoriums still available, but they ended at the end of February. So we only have March and we've said in the prior call too last quarter where we really going to see the aftermath of the moratoriums is in the month of March, which we're slightly talking about it here, but the confirmation will come in the Q2 of the year. And as I've said earlier, we're optimistic and cautiously optimistic about the trends here on the post moratorium delinquencies. Okay, great. And you had mentioned the funding side before and it looks like that was a real win for you guys this quarter. And non interest bearing deposits breaking the $1,000,000,000 mark, they had kind of bounced around in the high $800,000,000 Can you tell us if you have any idea where those deposits came from, where they hurricane related and what your expectation for the stickiness of those deposits are? Yes. So most of those deposits are coming from existing relationships we've had on the commercial side and some new ones, but it also is a reflection of the economy. There's a lot of cash in the economy and the consumers are spending the money and the money is going into some of our commercial clients and they're already making the deposits with us. So, I think it's a reflection on the early part of the recovery of the after Maria. And as I said, I'd like to confirm these trends in the Q2 to see if we can continue to move forward with progress on the economic front in Puerto Rico. Fico. Our next question comes from the line of Brett Rabatin with Piper Jaffray. Hi. I just wanted to follow-up on mortgage banking, which was really strong this quarter. One, was there anything from a fee perspective that was unusual? And then secondly, I mean this was basically as good as 4Q 2016 and much better than every quarter of last year even pre hurricane in those numbers. I mean obviously production was lighter than it could have been, but can the fee income side hang in there? [SPEAKER JOSE RAFAEL FERNANDEZ:] Mostly production, it's volume and cost being after the hurricane, we had a little bit of a hold back on the originating and selling. So in the quarter, we had a little bit of an accumulation there and that's why you're seeing higher fees. But also, it has to do with higher production levels that we had in the quarter. Okay. And then I just want to go back to the deposit account growth, 8%. Puerto Rico is obviously not growing population by 8%. Is the account growth reflective of wallet share or are you actually taking market share from your competitors? How should we think about that account growth this quarter? [SPEAKER JOSE RAFAEL FERNANDEZ:] So let me give a little bit of a comment here, but I'll let Ganesh answer that because he is actually very much involved and investments we've made in the past on technology and on people, and it's starting to pay off to us. But I'll let Ganesh go a little bit more in detail on that. We do have positive reputation as Jose pointed out. We are also having very aggressive efforts in our channel point to convert the one service customer, namely the loan customers into a deposit customer as well. So those efforts have been paid off a little bit and that's what you're seeing over here, Brett. So if you're asking me, are we taking market share, maybe it's more of increasing the wallet share than taking market share. Okay. Thanks for that. And then just lastly, Puerto Rico banks have been on hold for any kind of real capital deployment. And I guess from an investor perspective, how do you sort of gauge the prospects of maybe using some of your excess capital this year or should we have basically still you think have to wait until next year for anything meaningful to develop on that front? I think Brett that as we continue to deliver results as we've been doing in the last two quarters after Maria as the economy and hopefully the fiscal authorities in Puerto Rico execute on a fiscal plan that gives confidence to business people and investors alike. I think regulators will also come into the fray and feel more comfortable about the dialogue that we continuously have regarding capital management and capital deployment. So I am again repeating myself by saying that we are cautiously optimistic about that too given the results so far. Okay. Appreciate all the color. Thanks. Yes. You're welcome. At this time, there are no further questions. I would now like to turn the call over to management for closing remarks. Thank you, operator, and thank you all for listening in today. Looking ahead, we'll probably be scheduling our 2nd quarter conference call for Tuesday, July 24, and we'll be participating on the Piper Jaffray Bank Conference in Palm Beach on May 15. Until then, thank you again to everyone and have a good day and a great weekend.